Relative Valuation: EV/EBITDA, P/E and Comparable Companies
In the previous concept, Discounted Cash Flow (DCF) answered a fundamental question: what is a business worth based on its future cash flows. Relative valuation answers the market question: what is a business worth compared with how similar companies are being priced today. This matters in interviews because bankers rarely rely on one method alone - they use DCF for fundamental value and comparables for market context.
- Relative valuation values a company using the market pricing of comparable peers, unlike DCF, which values a company from fundamental cash flows.
- The main relative valuation methods in this lesson are EV/EBITDA, P/E, P/B, EV/Revenue, and examples such as P/GMV.
- DCF is typically used for long-term value investing, mergers and acquisitions, and fairness opinions, while comparables are useful for IPO pricing, quick screening, and reading market sentiment.
- Relative valuation is simple, market-based, and widely understood, but it is only as good as the comparable company set and can inherit market mispricing.
- Companies with many listed peers, such as consumer and IT companies, are better suited to trading comparables than companies with few relevant peers.
- In India, Paytm used EV/Revenue in IPO pricing and Nykaa used P/GMV, showing how market multiples can be adapted to the business model.
- In practice, investment bankers use a valuation football field to show the valuation range from multiple methods because no single method is definitive.
Before looking at individual multiples, place relative valuation beside intrinsic valuation. Discounted Cash Flow (DCF) means valuing a business using expected future cash flows. Dividend Discount Model (DDM) values equity using dividends, while Weighted Average Cost of Capital (WACC) is a discount rate used in DCF. Enterprise Value (EV), Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), Price to Earnings (P/E), Price to Book (P/B), Enterprise Value to Revenue (EV/Revenue), Free Cash Flow (FCF), Initial Public Offering (IPO), and Price to Gross Merchandise Value (P/GMV) are the key terms that appear in comparables.
What Relative Valuation Really Means
Relative valuation, also called comparables valuation, estimates value by comparing the target company with listed peers or transaction benchmarks. Instead of asking what the company is worth from first principles, it asks what the market is currently paying for similar businesses.
This is why relative valuation is the market-based counterpart to DCF. DCF depends heavily on internal assumptions such as WACC and growth, while comparables depend heavily on whether the peer set is relevant and whether the market pricing is reasonable. Both can be useful, but both can also be wrong in different ways.
In Indian usage, Paytm used EV/Revenue in IPO pricing and Nykaa used P/GMV. The strategic point is that bankers do not force one universal multiple on every company - they select a market multiple that fits how investors are pricing comparable business models.
Relative valuation asks: if comparable companies trade at a certain multiple of a relevant value driver, what valuation range should the target company command in the market.
Why Bankers Use Comparables Alongside DCF
DCF is theoretically rigorous because it is linked to fundamental cash flows. That makes it useful for long-term value investing, mergers and acquisitions, fairness opinions, investment banking DCF models, and private equity buyout models.
However, DCF is highly sensitive to assumptions. A change in WACC or growth can meaningfully change the output. Relative valuation helps address this by showing what the market is actually paying for peers today, which is especially useful for IPO pricing, quick screening, and understanding market sentiment.
The practical answer is not to choose one method and ignore the other. In practice, investment bankers use a valuation football field, which shows the range of values from multiple methods. The DCF anchors fundamental value, while trading and transaction comparables provide market context.
How EV/EBITDA Works
EV/EBITDA means Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation and Amortization. Enterprise Value represents the value of the business as a whole, while EBITDA is an operating profit measure before financing, tax, and non-cash depreciation effects.
In relative valuation, EV/EBITDA is used as a market multiple: if comparable companies trade at a certain EV/EBITDA range, the target can be evaluated against that range. The logic is simple - similar businesses should generally trade at broadly comparable valuation multiples, subject to differences in quality, growth, profitability, and market perception.
The nuance is that EV/EBITDA is still a comparable-company method. Its usefulness depends on whether the peer group is actually comparable. If the comp set is weak, the output may look precise but still be misleading.
EV/EBITDA = Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation and Amortization.
How P/E Works
P/E means Price to Earnings. It compares a company's equity value or share price with its earnings. In a comparable company analysis, analysts look at how the market values peer companies relative to their earnings and then use that as context for the target.
P/E is widely understood, which is one reason relative valuation is popular in interviews and market discussions. It gives a quick market-based reference point. But like all comps, it inherits the pricing of the peer group. If peers are overvalued or undervalued, the target valuation may inherit that mispricing.
P/E = Price divided by Earnings, or equity value divided by earnings in a company-level valuation context.
Other Comparable Multiples: P/B, EV/Revenue and P/GMV
The source set also highlights P/B and EV/Revenue as common relative valuation methods. P/B means Price to Book, while EV/Revenue compares enterprise value with revenue. These are useful reminders that the chosen multiple should match what the market is using to price comparable companies.
In Indian IPO pricing, Paytm used EV/Revenue and Nykaa used P/GMV. Gross Merchandise Value (GMV) is relevant in platform-style business models because investors may look beyond conventional earnings metrics when the market is pricing scale or transaction value. The key interview point is not to claim one multiple is always best, but to explain why a certain multiple fits the company and peer group.
Building a Comparable Company Analysis
A comparable company analysis starts with peer selection. The source content is clear that relative valuation is best for companies with many listed peers, such as consumer and IT companies. That is because the method depends on market pricing of peers, and a weak peer set weakens the conclusion.
Once peers are selected, the analyst chooses the relevant multiple, applies the peer valuation range to the target, and interprets the output as a range rather than a single truth. This is why bankers often place comps beside DCF in a football field.
Worked Example: Paytm and Nykaa in IPO Pricing
This worked example uses only the facts in the source: Paytm used EV/Revenue and Nykaa used P/GMV in IPO pricing. The lesson is about choosing a multiple that reflects how the market is pricing comparable businesses, not about calculating a specific rupee valuation.
The strategic takeaway is that relative valuation is flexible, but not arbitrary. A candidate should be able to justify why EV/Revenue fits one context and P/GMV fits another, while still acknowledging that market comparables can inherit mispricing.
Where Relative Valuation Works Best
Relative valuation works best when there are many listed peers and when the market has enough comparable pricing evidence. The source specifically points to consumer and IT companies as examples of sectors where listed peers can make comparables more practical.
It is also useful when speed and market readability matter. IPO pricing, quick screening, and market sentiment analysis are all situations where a market-based method can be more immediately interpretable than a detailed DCF.
Where Relative Valuation Fails
The biggest limitation is peer quality. Relative valuation is only as good as the comp set. If the peers are not truly comparable, the valuation range can become misleading even if the mathematics looks clean.
The second limitation is inherited mispricing. If the market is incorrectly pricing the peer group, then a relative valuation may simply transfer that mispricing to the target. This is why no single method is definitive and why bankers combine DCF with trading and transaction comparables.
Structuring a Relative Valuation Interview Answer
"How would you value a company using relative valuation, and how would you reconcile it with a DCF?"
The strongest answers do not just list multiples. They explain why a multiple fits the company, when the method is useful, and why the result should be cross-checked against DCF in a valuation football field.
Conclusion
Relative valuation is the practical market lens that complements DCF. Use it to understand how peers are priced, use DCF to anchor fundamental value, and use the football field to show that valuation is a range of informed judgments rather than a single definitive number.
The most frequent mistake is treating a comparable multiple as automatically correct. This costs points because relative valuation can be distorted by a weak comp set or inherited market mispricing, so the answer must always explain peer quality and cross-check the output against DCF.